The Treasury is changing the methodology it uses to forecast house prices by putting more weight on the impact of interest rates.
Its chief economic advisor Dominick Stephens told Parliament’s Finance and Expenditure Committee of the change on Wednesday, explaining the Treasury is accordingly reducing the relative weight it gives to physical supply and demand factors.
He noted how since the onset of Covid-19, the number of new houses built has increased and the number of people who have migrated to New Zealand has decreased, but still house prices have shot up.
The Treasury has always factored interest rates into its house price forecasts, but Stephens acknowledged it hadn’t put enough weight on this factor.
The Treasury at the May 2021 Budget forecast CoreLogic’s Quarterly House Price Index rising by 17.3% in the year to June 2021. But as it turned out, the index rose by a whopping 29.0%.
Interest rates are such a big deal because land supply is so inflexible
Speaking to interest.co.nz, Stephens couldn’t put numbers on how the Treasury had altered weightings given to different influences on house prices, but characterised the change as “meaningful”.
“I do think all forecasters in New Zealand need to consider the evidence of the past couple of years,” he said.
“The past couple of years have changed the information set available to us. We hadn’t really seen a period before where interest rates diverged so radically from physical supply/demand factors.”
Stephens said the Treasury made the change following research it did with the Reserve Bank (RBNZ) and the Ministry of Housing and Urban Development. The three agencies came together to form a Housing Technical Working Group in June.
He said the group concluded, “The biggest driver of house price increase over the past 30 years in New Zealand is a decline in global interest rates in the context of longstanding issues around the supply of land in New Zealand…
“The less flexible land supply is, the more you see interest rate changes affecting prices.
“This is longstanding issue in New Zealand, and I think that’s why the Treasury is quite focussed on the supply of land in our advice [to the government] around housing.”
Stephens said the Treasury’s new model was used to forecast house price in its Half Year Economic and Fiscal Update, published on December 15.
It forecast CoreLogic’s Quarterly House Price Index falling by 0.2% in the year to June 2022. The index rose by 5% between the June and September 2021 quarters, accordingly to the latest available data.
Could this ultimately affect the way the RBNZ sets interest rates?
Interest.co.nz has asked the RBNZ whether it has likewise changed the method it uses to forecast house prices. The Bank is yet to respond.
The RBNZ in August conceded its house price forecasts had consistently undershot reality over the past decade, thanks to immigration levels being higher, and interest rates lower than expected.
“Since 2010, on average our forecasts for annual house price inflation one year in the future have been out by 5.2 percentage points,” the RBNZ said in commentary prepared for the Finance and Expenditure Committee.
Green Party committee member, Chlöe Swarbrick, said Labour Party members have blocked 22 requests she has made for the Treasury and RBNZ to appear before the Committee to discuss their house price forecast methodologies.
Asked what she made of the information Stephens shared, Swarbrick said, “This is the first insight we have into what’s going on there and I hope to get more out of it with follow-up questions.”